he volume of distressed nonagency residential mortgage properties in the U.S. continues to fall, but at an ever-slowing pace. Standard & Poor's Ratings Services currently estimates that the principal balance of these distressed homes amounts to about $450 billion, representing nearly one-third of the nonagency residential mortgage-backed securities (RMBS) market currently outstanding. We define this yet-to-be absorbed "shadow inventory" of distressed properties as outstanding properties whose borrowers are (or recently were) 90 days or more delinquent on their mortgage payments, properties currently or recently in foreclosure, or properties that are real estate owned (REO).

At the end of fourth-quarter 2010:

We estimate it will take 49 months, or more than four years, to clear the supply of distressed homes on the market in the U.S. as a whole. This is an 11% increase over the previous quarter and a considerable 40% increase from fourth-quarter 2009 for the average time to clear these properties in the U.S.

Miami is the only top-20 metropolitan statistical area (MSA) for which our estimate of the time to clear the inventory of distressed properties remained stable since the fourth quarter of 2009.

Although the Los Angeles MSA has the largest current overhang balance, the shadow inventory in the New York MSA will take the longest to clear--130 months as of fourth-quarter 2010. That is at least twice as long as it will take in any of the other top 20 MSAs and 2.7 times the average time to clear for the U.S. as a whole. This is primarily due to very low liquidation rates in New York.

Table 1

Shadow Inventory For The Top 20 U.S. Markets

Months of inventory at end of quarter (No.)

MSA

Orig. bal outstanding (bil. $)

Current overhang bal (% of bal. outstanding)

4Q10

3Q10

2Q10

1Q10

4Q09

Course of inventory levels since last quarter (%)

2010 Year-to-date course of inventory levels (%)

Atlanta

25

29.58

49

44

41

40

35

Up 13

Up 41

Boston

20.5

31.53

71

62

60

59

54

Up 14

Up 30

Charlotte

4.8

26.55

65

52

47

48

44

Up 26

Up 49

Chicago

37.2

39.55

59

52

48

45

42

Up 14

Up 41

Cleveland

4.1

34.53

57

47

43

40

36

Up 20

Up 60

Dallas

16.4

21.39

56

46

41

43

41

Up 24

Up 39

Denver

14.3

21.78

38

35

33

32

28

Up 10

Up 36

Detroit

12.1

33.72

31

30

27

25

22

Up 3

Up 43

Las Vegas

22.9

48.80

33

30

28

24

20

Up 9

Up 62

Los Angeles

173.1

31.47

50

45

43

41

36

Up 11

Up 38

Miami

57.8

56.11

60

60

64

64

60

Stable

Stable

Minneapolis

13.3

28.43

38

35

32

27

21

Up 10

Up 77

New York

116.7

36.75

130

119

115

107

100

Up 9

Up 31

Phoenix

29.4

36.80

25

23

21

20

17

Up 10

Up 49

Portland

10.5

27.40

51

45

38

34

31

Up 12

Up 65

San Diego

45.8

28.38

39

35

32

31

27

Up 12

Up 43

San Francisco

77

23.26

42

38

34

32

28

Up 11

Up 53

Seattle

24.4

28.03

59

54

48

45

42

Up 10

Up 42

Tampa

15.8

47.96

57

55

55

55

51

Up 3

Up 12

Washington

60

26.47

50

44

40

37

33

Up 13

Up 52

Total U.S. market

1,358.80

33.15

49

44

41

39

35

Up 11

Up 41

MSA--Metropolitan statistical area.

Overall, the value of the Federal Housing Finance Agency (FHFA) home price index indicates that home prices have fallen 20% from their heights in early 2007. Moreover, prices are likely to fall further as the distressed properties comprising the inventory are sold and the backlog clears (see chart 1).

Chart 1

Prior to first-quarter 2008, in which our estimates of months to clear the shadow inventory reached peak levels, the increases in months to clear were primarily attributable to sharp increases in overall distressed property levels that resulted from higher default rates. However, our recent estimates of months to clear have increased primarily because of the deceleration of the distressed property liquidation rate rather than a rise in overall distressed property levels (see chart 2). Our estimate of months to clear for the overall U.S. market has increased by five months since the third quarter.

Chart 2

Liquidation rates are falling in part because of increasing timelines for resolving troubled assets. Relative to the volume of distressed properties overall, REO assets, or those that are bank owned, remain at minimal levels (see chart 3). It seems that 90-plus-day delinquent loans and foreclosed properties are taking longer to become REO, which is lengthening the overall timelines for resolving troubled assets.

Chart 3

Despite the size of the shadow inventory, some of the recent news is good:

The overall level of distressed loans continues to decline; and

Loan cure success rates have been improving since the second half of 2008, and the recidivism rates for loans cured or modified in fourth-quarter 2009 were significantly lower than for previous periods. Almost 80% of the loans modified or cured for the first time during first-quarter 2008 re-defaulted within the first year of modification, compared with 45%-50% of those modified or cured in fourth-quarter 2009 (see chart 4). Nonetheless, the volume of modified loans (about 17% of the total overhang) is minimal relative to the balance of the remaining loans that are still distressed (see chart 3).